Owning a recreational property is a very commonly stated objective in many Canadian Families’ Financial Plan. Most vacation properties are located in Canada or the United States, however in recent years we have noticed an increase in the number of home purchases being made further abroad. Regardless of where you have decided to buy recreational property there are tax implications when it comes time to sell, transfer, or bequeath your recreational property. If you derive rental income from the property things get even more complex. By exercising some due diligence prior to making your dream purchase, you have the opportunity to realize some significant tax planning advantages.
Prior to beginning your search for the perfect property it is important to identify the use cycle of the property. What I am referring to is how will you be using the property and do you intend to dispose of the property at some point in the future? Most people buy a vacation home for
- Rental purposes
- Combination of personal use and periodic or seasonal rentals
- Personal use with a long term hold plan.
Is the property something you want to sell upon the attainment of some goal such as retirement or your children graduating from school? The Planning implications for each need to be taken into account in order to maximize your tax planning advantages. My hope is that by providing you with an overview of the types of tax issues and strategies worth consideration, it will stimulate awareness and motivate you to do some prudent tax and estate planning. The benefits of tax and estate planning will be apparent when you dispose of the property. This occurs when you choose to sell the property or when you pass away.
1-Selling the Property during your lifetime- In Canada you are able to apply your principal residence exemption to the sale of your principal residence in order to shelter the gains from taxation. However there is no such exemption on secondary properties. As such there may be taxation on the capital gains realized upon the sale of your recreational property. Depending on your circumstances there may be an opportunity to minimize taxes by designating one of your two properties as your principle residence for tax purposes. For properties located abroad it is important to understand the implications of selling your property. It is a common requirement that you report the loss or gain from the sale of your foreign property on your Canadian tax return as well as to the foreign country’s tax department. Since tax laws, regulations and filing forms vary greatly from one country to the next it is important to speak with an account who is skilled in foreign tax matters prior to making your purchase.
2-Death and Bequeathing the property- Many people want to pass the family cottage on to the next generation for their children and grandchildren to enjoy after their passing. Upon death your property may be subject to probate and capital gains tax. Regardless of if you actually sell your property or not, there is a deemed disposition on your assets upon death which can have a substantial financial impact on your estate. Often we see that the property has to be disposed of in order to settle the tax liability of the estate, thereby thwarting your dream of leaving the cottage to the kids. This unwanted result can be avoided with some relatively basic planning. Below I have outlined 3 of the more common strategies used;
a)Own property as Joint Tenant- In order to avoid the property forming the assets of the estate and being subject to probate, some individuals choose to register the property in joint names or joint tenancy with their child. If one owner dies, their equity in the property automatically transfers to the surviving owner outside of the estate and therefore avoids probate tax. One of the major drawbacks to this strategy is that the original owner will be giving up some form of control of the property to the joint owner. There are other serious implications to owning a property as joint tenants as well that should be carefully considered before structuring ownership of the property.
b)Use Life Insurance to pay the taxes-One of the most cost effective ways to pay the capital gains tax on a property upon death is to use the tax free proceeds of a life insurance policy to settle the liability. Depending on your age, medical condition, and financial position, it is reasonably simple to run a projection of the expected tax liability on the disposition of the recreational property upon death. A life Insurance policy is then put in force on the life of the owner for the projected amount of taxes due. When the owner dies the life insurance policy will provide the estate with the liquid capital necessary to pay the tax bill on the cottage. It can then be transferred from the estate to the beneficiaries as intended. It is not uncommon for the beneficiaries to carry the cost of the insurance policy as it is ultimately for their benefit and not that of the current owner.
c)Holding the property in a trust- Another strategy that is commonly used is owning the property in some form of trust. This allows you to maintain full control over the property through the trust (unlike registering the property as joint tenants). Your children could be named as beneficiaries of the trust and as such would inheret the assets within the trust upon your death. Any future capital gains would be deferred until your beneficiaries ultimately sell the property.
For homes that are located abroad you must take into consideration both Canadian Tax implications as well as the tax implications for the country in which the home is located. Furthermore it is important to understand how property ownership works in a foreign country. It is recommended that when making a vacation property purchase abroad that you use a local Real Estate Lawyer familiar with the area to research details such as
- Local Zoning and Building Restrictions and Opportunities
- Municipal Taxes/service fees
- Property Management details
- HOA/Strata Fees associated with the property/development
- Any other concerns you may have.
As with any tax planning, it is important that you obtain customized advice for your own situation from a professionally qualified accountant, estate planning lawyer and financial planner. As tax, legal, and estate planning issues are frequently intertwined it is important that your financial plan take all these issues into consideration. As part of a planning team we at Bumstead Financial Services offer our clients access to a wide range of estate and financial planning experts. If you have any questions or concerns or would like to arrange a discovery meeting with an advisor, then please don’t hesitate to contact us at info@bumsteadfinancial.com
